What?! The world’s most famous freemarket economist a former Keynesian?

Yes, it’s true. One of the more remarkable revelations in Milton and Rose Friedman’s new autobiography, Two Lucky People, is Milton Friedman’s flirtation with Keynesian economics in the early 1940s. During his stint with the Treasury Department, Friedman was asked to give testimony on ways to fight inflation during World War II. His reply, couched in Keynesian ideology, mentioned several options: cutting government spending, raising taxes, and imposing price controls. Amazingly, nowhere did he mention monetary policy or controlling the money supply, the things Friedman is famous for today.

During the 1930s, Friedman had also favored Keynesian-style deficit spending as a way out of the Great Depression. His mentor was not Keynes himself but Friedman’s teachers at the University of Chicago. Friedman recounts, “Keynes had nothing to offer those of us who had sat at the feet of [Henry] Simons, [Lloyd W] Mints, [Frank] Knight, and [Jacob] Viner.” 2 In short, Chicago economists were Keynesian before Keynes.

In his autobiography, Friedman says he was “cured” of Keynesian thinking “shortly after the end of the war,” but doesn’t elaborate. In a recent letter, he denies ever being a thorough Keynesian. “I was never a Keynesian in the sense of being persuaded of the virtues of government intervention as opposed to free markets.” It should also be pointed out that Friedman’s teachers at Chicago blamed the Great Depression on “misguided government policy.” Friedman indicates he was “hostile” to the Keynesian idea that the Depression was a market phenomenon. 3

Despite these statements, many free-market economists have long accused Friedman of being a quasi-Keynesian.

On December 31, 1965, Time magazine put John Maynard Keynes on the cover and quoted Friedman as saying, “We are all Keynesians now.” Later, Friedman said he was quoted out of context. “In one sense, we are all Keynesians now; in another, no one is a Keynesian any longer. We all use the Keynesian language and apparatus, none of us any longer accepts the initial Keynesian conclusions.” 4

In an article published in 1986, Friedman glorified Keynes as a “brilliant scholar” and “one of the great economists of all time.” He described The General Theory as a “great book,” although he considers his Tract on Monetary Reform as his best work. Moreover, he declared, “I believe that Keynes’s theory is the right kind of theory in its simplicity, its concentration on a few key magnitudes,its potential fruitfulness.” 5

Many conservatives wonder how Milton Friedman, defender of free markets, could speak so highly of a man considered the intellectual architect of the postwar inflation and the modern welfare state.

Friedman is known as the leader of the Monetarist opposition to the Keynesian revolution. According to Friedman, monetary policy (manipulation of the money supply and interest rates) influences economic activity far more than fiscal policy (taxes and government spending). Yet it must be remembered that monetary and fiscal policies are both forms of state intervention in the economy. Accordingly, some free-market advocates see Keynes and Friedman as partners in crime.

Granted, Friedman, as opposed to the Keynesians, favors a strict limit on monetary growth. Yet even Friedman occasionally succumbs to interventionist fever. Late last year he endorsed this remedy for Japan’s sluggish economy: print more money. Apparently Friedman felt that the easy-money policy in effect in Japan since 1994 (recent M1 was growing at 9.9 percent, M2 at 4.3 percent) was insufficient. “The surest road to a healthy economic recovery,” he wrote, “is to increase the rate of monetary growth.” What about tax relief, deregulation, and open markets? Friedman failed to list any of these options. 6

Undoubtedly he favors these remedies, but the article rekindled the old accusation that “only money matters” to Friedman.

Friedman the Anti-Keynesian

I have to admit that, like many free-market economists, I am surprised by these findings and the favorable comments Friedman has made about Keynes. I’ve always viewed the leader of the Chicago school as strongly anti-Keynesian. His Monetary History of the United States clearly contradicts Keynes’s contention that the capitalist system is inherently unstable. 7 The book shows that the Fed’s inept policies, not free enterprise, caused the Great Depression. Friedman’s permanent-income hypothesis modifies Keynes’s consumption function and undermines the case for progressive taxation. His natural-rate-of-unemployment doctrine denies any long-run trade-off between inflation and unemployment (the Phillips curve). In Capitalism and Freedom, Friedman challenges the effectiveness of the Keynesian multiplier and declares that the federal budget is the “most unstable component of national income in the postwar period.” 8 And, as early as 1963, he labeled as “erroneous” the Keynesian proposition that the free-market economy can be stuck indefinitely at less than full employment. 9

So where does that leave us? In one of the more controversial contributions to my edited volume Dissent on Keynes, Roger Garrison of Auburn University asks, “Is Milton Friedman a Keynesian?” Garrison contends he can argue it either way. Indeed. Yet, in the final verdict, I can’t help but think that Friedman, as an open-minded scholar, is willing to investigate and test all theories, no matter their source, and this methodology has gradually led him to discard most of Keynesianism. As he himself has written, “I have been led to reject it… because I believe that it has been contradicted by experience,” 10

1. Milton and Rose Friedman, Two Lucky People (Chicago: University of Chicago Press, 1998), p. 113.

“I used to love hedgehogs but those were ‘my salad days when I was green in judgement’. Now I prefer foxes–Smith over Ricardo, Mill over Senior, Marshall over Walras.” — MARK BLAUG 1

Last November, I reported on three economists who courageously reversed their published views. Now, I’d like to add a fourth: Mark Blaug. He is a prolific and intense writer, and most famous for his arduous textbook, Economic Theory in Retrospect (Cambridge University Press, 1997), now in its fifth edition. Blaug is primarily a historian of economic ideas and as such, he is, to borrow from Peter Drucker, a “bystander,” an unbiased reporter and critic of economic ideas. And my, does Mark Blaug write with profundity and wit. His latest work, Not Only an Economist: Recent Essays by Mark Blaug, is one of the most delightful books I’ve read in a long time. I found myself making notes and exclamation points on practically every page.

As perhaps the most profound keeper of economic thought since Joseph Schumpeter, Blaug has made remarkable progress. His unrelenting search for truth has led him along the intellectual road from Karl Marx to Adam Smith, and even now shows increasing sympathy with Joseph Schumpeter, Friedrich Hayek, and the Austrian school.

Blaug’s intellectual odyssey is curiously broad: like Whittaker Chambers, he started out a Marxist and a card-carrying member of the American Communist Party, then became disillusioned and betrayed. He flirted with Freud, but now recognizes Freudian psychology to be a “tissue of mumbo-jumbo.” Regarding religion, Blaug “was brought up an orthodox Jew, achieved pantheism by the age of 12, agnosticism by the age of 15, and militant atheism by the age of 17.” 2 He has shifted ground as frequently as he has transferred allegiance: born in the Netherlands, educated in the United States, and now a resident of Great Britain.

The Perversity of Ricardo, Marx, and Sraffa

Blaug’s sojourn in economics is equally diverse. Leaving Marx, he became a convert to the British economist David Ricardo, wrote his Ph.D. dissertation on Ricardian economics, and even named his first son after him. But eventually he concluded that Ricardian economics is flawed and too formalistic. Blaug is especially disturbed by the development of a perverse version of Ricardian economics known as Sraffian economics. Sraffian economics is named after Piero Sraffa, author of the obscure theoretical work Production of Commodities by Means of Commodities (Cambridge University Press, 1960), which has highly influenced Marxists and post-Keynesians. Essentially, Sraffa uses a Ricardian model to claim that national output is completely independent of wages, prices, or consumer demand. Accordingly, governments can pursue their grandest redistributive schemes without damaging economic growth in the least.

In a scathing critique of The New Palgrave Dictionary of Economics, Blaug lambastes Sraffian economics as mathematically obtuse and irrelevant to the real world, and assails the editors for citing Marx and Sraffa “more frequently, indeed, much more frequently, than Adam Smith, Alfred Marshall, Leon Walras, Maynard Keynes, Kenneth Arrow, Milton Friedman, Paul Samuelson or whomever you care to name.” 3

Recently, Blaug has criticized modern economics for the “noxious influence” of Swiss economist Leon Walras in creating the “perfectly competitive general equilibrium model,” or GE for short. Most of the textbook writers, including Paul Samuelson, are enamored with GE, because of its mathematical precision. For example, the perfect competition model focuses on the final end-state of competition, rather than the competitive process itself. Blaug labels perfect competition a “grossly misleading concept” that ignores the role of the entrepreneur. He urges economists to “rewrite the textbooks” and replace the current Walrasian GE model with the dynamic Austrian view of the competitive process. 4

Blaug on Anstrian Economics

Joseph Schumpeter, FA. Hayek, and Israel Kirzner have been in the forefront of developing the Austrian view of competition. Blaug writes favorably about them all. Although belittling Mises’s methodology (“cranky and idiosyncratic”) and his business-cycle theory (“empty”), he grants Mises and Hayek “the better case” in the socialist calculation debate. He rates Schumpeter’s The Theory of Economic Development (1911) one of the three most important books ever written by an economist. Ultimately he prefers Hayek: “In short, it is Hayek, not Mises, who deserves to be patron saint of Austrian economics.” 5

Incomplete Conversion

Blaug’s conversion toward free-market capitalism is on the right track. He has gradually shifted toward Adam Smith and Hayek, though he is still enamored with John Maynard Keynes, who he says caused a “permanent revolution.” Keynes divides the time line between Blaug’s two biographical works, Great Economists Before Keynes and Great Economists Since Keynes. His current attitude is summed up as “capitalism tempered by Keynesian demand management and quasi-socialist welfarism.” 6 Hopefully, that’s not the final word on his economic philosophy.

One last note. Regarding Blaug’s intolerance of religion, I’m reminded of G.K. Chesterton’s response to H.G. Wells’s atheism: “H.G. suffers from the disadvantage that if he’s right he’ll never know. He’ll only know if he’s wrong.” 7 And the last thing that Mark Blaug wants to find out is that he is wrong.

Fill in the blank. Who is the mysterious economist named above? Most of my colleagues named Milton Friedman, but in Daniel Yergin and Joseph Stanislaw’s bestseller, the Chicago economist runs a close second to….

F.A. Hayek, the Austrian economist!

Why Hayek? Because, according to Yergin and Stanislaw, Hayek has done more than any other economist to debunk socialism in its many forms–Marxism, communism, and industrial planning–and to promote free markets as an alternative system. Hayek’s influence perfectly illustrates John Maynard Keynes’s remark that politicians, “madmen in authority,” are the “slaves of some defunct economist.”2

Indeed, Hayek’s influence has been ubiquitous. As Yergin and Stanislaw point out, The Road to Serfdom greatly affected Margaret Thatcher in reforming Great Britain and raised doubts about industrial planning. Hayek’s criticisms of Keynesianism (A Tiger by the Tail) called into question deficit spending and the ability of the state to fine-tune the economy. His theory of decentralized knowledge and competition as a discovery process has had an impact on microeconomic theory and experimental economics. His work on the trade cycle and the denationalization of currencies has influenced monetary policy. His co-founding of the Mont Pelerin Society spread the gospel of free markets, property rights, and libertarian thought throughout the globe.3

A Surprising Victory

Yergin and Stanislaw’s revelation in The Commanding Heights: The Battle Between Government and the Marketplace That Is Remaking the World is a monumental victory for Austrian economics. It is all the more remarkable given Yergin’s background as an establishment journalist and author of The Prize, a Pulitzer Prize-winning book about big oil.

At the beginning of this decade, I argued in Economics on Trial that the “next economics” would be the Austrian model, with its focus on entrepreneurship, microeconomics, deregulation, savings, free enterprise, and sound money.4 But even I am surprised how rapidly Hayek and the Austrian school have achieved recognition.

The next step is to see how quickly the economics profession absorbs Austrian economics in its theories and textbooks. A quick review of the current top-ten textbooks reveals only two with significant entries on Hayek and the Austrians: Roy Ruffin and Paul Gregory’s sixth edition of Principles of Economics, and James Gwartney and Richard Stroup’s eighth edition of Economics: Private and Public Choice. Ruffin and Gregory give credit to Hayek (and Mises) for the fall of socialism, one of Ruffin and Gregory’s “defining moments in economics.” Curious note: Ruffin and Gregory’s fifth edition had no references to Hayek or Mises; clearly Ruffin and Gregory are quick to recognize a paradigm shift.

Other textbook writers are not so prescient. Samuelson’s 16th (50th anniversary) edition highlights only Joseph A. Schumpeter. Textbooks by David Collander, John Taylor, and Joseph Stiglitz cite Hayek only once, while top sellers by Roger LeRoy Miller; Michael Parkin; William Baumol and Alan Blinder; Campbell McConnell and Stanley Brue; and Paul Heyne make no references to Hayek and the Austrians.

A Tale of Two Cities

Yergin and Stanislaw rightly point to two schools of free-market economics responsible for the shift from government to private enterprise as the solution to world economic problems. “And the eventual victory of this viewpoint was really a tale of two cities–Vienna and Chicago,” declare the authors.5

In the judgment of many economists, Milton Friedman and the Chicago school have had even a greater influence than Hayek and the Austrians. Yergin acknowledges Friedman as “the world’s best-known economist,” noting that “the Chicago School loomed very large” in its sway on monetarism at the Federal Reserve and economic policy (under Ronald Reagan). And, of course, all top-ten textbooks in economics have significant sections on Friedman and his theories (monetarism, natural rate of unemployment, welfare reform, privatization). Friedman and the Chicago school have mounted an effective counter-revolution to Keynesianism.

The Great U-Turn

But Keynes’s principal rival in the 1930s was Hayek. Teaching at the London School of Economics, Hayek defended the classical model of thrift, balanced budgets, the gold standard, and free markets, while Keynes (Cambridge University) promoted the “new economics” of consumption, deficit spending, easy money, and big government. Keynes won the first battle for the hearts of economists, and his brand of “mixed economy” swept the profession. Hayek fell out of favor and went on to write about law and political science. The task of dethroning Keynes fell to Friedman; he has accomplished it masterfully.

Since winning the Nobel Prize in economics in 1974, Hayek and the Austrians have had a rebirth. Equally, Friedman and the Chicago school have come out of obscurity into prominence. Fifty years ago the Keynesian-collectivist consensus expressed the sentiment, “The state is wise and the market is stupid.” Today, the growing consensus is just the opposite: “The market is wise and the state is stupid.”

Break out the champagne. It’s time to celebrate.

1. Daniel Yergin and Joseph Stanislaw, The Commanding Heights: The Battle Between Government and the Marketplace That Is Remaking the Modern World (Simon & Schuster, 1998), p. 15.

3. For a good overview of Hayek’s works, see The Essence of Hayek, ed. Chiaka Nishiyama and Kurt R. Leube (Stanford, Calif.: Hoover Institution, 1984). For a partial autobiography, see Hayek on Hayek (Chicago: University of Chicago Press, 1994). A full-scale intellectual biography of Hayek has been completed by Alan Ebenstein, Hayek: Philosopher of Libertarianism (forthcoming).

In 1992, Harvard Prof. Greg Mankiw was paid an unprecedented advance of $1.1 million to produce the “next Salmuelson”–a successor to Paul Samuelson’s “Economics,” the most successful economics textbook ever written, with more than four million copies sold in 15 editions and 41 foreign translations since 1948. Mr. Mankiw’s 800-page “Principles of Economics” has now been published, to great publicity. And for good reason: Mr. Mankiw has written a revolutionary–or rather, counterrevolutionary–work.

Virtually the entire book is devoted to classical economics, leaving the Keynesian model as an afterthought in the end chapters. Mr. Mankiw’s pedagogy is all the more remarkable given that he considers himself a “neo-Keynesian.” His liberal bias has allowed him to do what no other mainstream economist dares: He has betrayed Keynes.

Almost all economics textbooks published in the past 50 years have taken their cue from Mr. Samuelson, whose major influence was John Maynard Keynes’s “The General Theory of Employment, Interest and Money” (1936). Keynes’s book taught that Adam Smith’s classical model–founded on the virtues of thrift and balanced budgets, laissez faire capitalism and free trade–was a “special” case and only applied in times of full employment.

Keynes’s model portrayed the market as a driver without a steering wheel, a driver that could push the economy off the road at any time. He taught that the economy needed a large and activist government to steer it on the road of full employment. Keynesianism, or the “new economics,” became widespread–the “general” theory.

Modern economics textbooks thus focused primarily on the ups and downs of the capitalist system and how government policy could attempt to ameliorate the business cycle. They include many chapters studying cyclical fluctuations, while burying the study of economic growth and development–otherwise known as supply-side economics–in the back pages. Now Mr. Mankiw has changed all that, putting classical economics back at the forefront, where it belongs.

This is more than some free-market economists have been able to accomplish in tile past. James Gwartney and Richard Stroup, authors of “Economics: Private and Public Choice” (Dryden, 1997), don’t believe in the Keynesian model of aggregate supply and aggregate demand, or AS-AD, but they were forced to include it by their publisher’s review board, which consists of mainstream economists. Roger LeRoy Miller, author of another best-selling textbook, “Economics Today” (Addison-Wesley, 1997), told me, “AS-AD is a bunch of nonsense, but I’m required to teach it.” (One small victory: Paul Heyne refused to put AS-AD in his “The Economic Way of Thinking” (Prentice-Hall, 1997) and got away with it because he writes for a niche market.)

So, in a Nixon-goes-to-China twist, it took a Keynesian to accomplish what the free-market economists couldn’t–relegating Keynesian models to a minor role in textbooks.

Mr. Mankiw calls his classical model “the real economy in the long run.” His textbook, published by Harcourt Brace’s Dryden Press, teaches that increases in government spending crowd out private capital, producing higher interest rates. Higher thrift and greater savings produce lower interest rates and higher economic growth. Unemployment is caused not by greedy industrialists, but by minimum wage laws, collective bargaining, unemployment insurance and other regulations that raise the cost of labor.

Mr. Mankiw even approvingly quotes Milton Friedman: “inflation is always and everywhere a monetary phenomenon”–not the product of rising labor or supply costs, as many Keynesians believe. In fact, Mr. Mankiw cites Mr. Friedman more than he cites Keynes.

This is not to say that Mr. Mankiw’s textbook isn’t without a few sins of omission. He fails to tell students about the great postwar economic miracles of Japan, Germany, Hong Kong, Singapore and Chile. He also ignores the current debate over Social Security privatization. And there are no references to the great Austrian economists Ludwig von Mises and F.A. Hayek, or to Nobel laureate James Buchanan and the public choice theory he espouses.

But these complaints are small compared with the book’s overall message, that classical economics is now the “general” theory and Keynesian economics is the “special” case. Amazingly, Mr. Mankiw doesn’t mention most of the standard Keynesian analysis: No “consumption function,” no “Keynesian cross,” no “propensity to save,” no “paradox of thrift”– and only one short reference to the “multiplier”!

“I don’t care who writes a nation’s laws … if I can write its economics textbooks.” –Paul A. Samuelson

When I majored in economics in the late 1960s and early 1970s, there were precious few textbooks with a strong free market bent. My introductory course required Paul A. Samuelson’s Economics, a strictly Keynesian work favoring heavy state intervention. My class in the history of economic thought relied on The Worldly Philosophers, by Robert Heilbroner, a socialist who said that Karl Marx was a good family man. My economic history book was History of the American Economy, by Ross M. Robertson, who wrote that high federal deficit spending got us out of the Great Depression. And this was at Brigham Young University, a conservative institution.

Fortunately, free-market economists have gradually filled a gap by teaching sound principles at every level of economics. There’s still much more to do, but the direction is clear–more textbook writers are producing books that teach market principles.

Here are my choices for the best textbooks in each category:
Introductory Texts: Significant Progress

There are quite a few introductory texts to choose from. Most of my colleagues select The Economic Way of Thinking, by Paul Heyne (University of Washington), now in its eighth edition (Prentice-Hall, 1997). It focuses primarily on the micro foundations of the economy and avoids defective macro concepts such as aggregate supply (AS) and aggregate demand (AD). Economics: Private and Public Choice, by James D. Gwartney (Florida State) and Richard L. Stroup (Montana State), now in its eighth edition (Dryden Press, 1997), is another favorite. It consistently applies market principles to a host of problems, including the environment, taxes, and government spending. It is the only textbook I know that spends several pages on Social Security privatization.

The only drawback is that it begins its macro section with AS-AD, a fundamentally Keynesian concept (the idea that the economy can be stuck indefinitely at equilibrium at less than full employment). Gwartney and Stroup should take a cue from Greg Mankiw’s popular new textbook, Economics (Dryden Press, 1997), which begins its macro section with the classical model (which he terms “the real economy in the long run”) and relegates the short-term
AS-AD model to the back of the book. AS-AD is introduced in chapter 8 of Gwartney and Stroup but chapter 31 in Mankiw!

Another free-market textbook that puts classical economics ahead of the Keynesian model is Principles of Economics (Addison-Wesley, 1997) by Roy J. Ruffin and Paul R. Gregory, both professors at the University of Houston. They introduce AS-AD in chapter 27. Economic growth (the long-run classical model) is emphasized over the ups and downs of the business cycle (short-run Keynesian model).

Ruffin and Gregory have many other advantages: They are the only major textbook to cite favorably the Austrian economists Ludwig von Mises, Friedrich Hayek, and Joseph Schumpeter throughout the textbook, including the first chapter. Most textbooks quote liberally from John Maynard Keynes, Milton Friedman, and Karl Marx, but Ruffin and Gregory break new ground here. The authors focus on four major historical events (“Defining Moments in Economics”) and their impact on economic thinking: the industrial revolution, the rise and fall of socialism, the Great Depression, and globalization. They also devote major sections on privatization, public choice, the gold standard, and economic success stories in Europe and Asia.

Overall, the works by Ruffin and Gregory, and Gwartney and Stroup, are quickly becoming known as the most innovative textbooks on the market today.

Breakthrough in American Economic History

Now let’s turn to economic history. Gene Smiley (Marquette) has written a first-rate textbook for American economic history classes: The American Economy in the Twentieth Century (South-Western Publishing, 1993). It is the only textbook I know that considers all the major conflicting theories for explaining the major events of the twentieth century. It even includes an Austrian interpretation of the Great Depression and the World War II economy. I just wished Smiley covered events prior to the twentieth century; his book is that good.

History of Economic Thought

Many economics teachers have wisely replaced Heilbroner’s Worldly Philosophers with New Ideas from Dead Economists, by Todd G. Buchholz (Plum, 1990). Among other things, Buchholz is much more critical of Marx and central planning. Unfortunately, Buchholz’s book says almost nothing of the Austrian school. One book that does is A History of Economic Theory and Method, by Robert B. Ekelund, Jr., and Robert F. Hebert (McGraw-Hill, 1990). Murray N. Rothbard originally intended to write a one-volume history of economics, but his work gradually developed into a series of tomes, only two of which were completed before his untimely death: Economic Thought Before Adam Smith and Classical Economics (Edward Elgar, 1995). Both books are more appropriate for advanced courses in economic theory and philosophy.

Other free-market books may be helpful in various courses. For money and banking classes, Murray Rothbard’s The Mystery of Banking (E. P. Dutton, 1983) is useful. Dominick T. Armentano’s Antitrust and Monopoly, second edition (Holmes & Meier, 1990) is an ideal supplement in classes on industrial organization. And, of course, there is a wide variety of books on free-market economics to supplement the textbooks–works by Ludwig von Mises, Friedrich Hayek, Israel Kirzner, Henry Hazlitt, George Reisman, Hans Sennholz, and a host of others.

Jo Ann Skousen’s Odds & Trends

Movie reviews, theater reviews, and commentaries by Jo Ann Skousen, author, editor, professor and Mark's wife of 41 years. She is the Festival Director for the Anthem Libertarian Film Festival and the entertainment editor for Liberty Magazine.

Mark Skousen’s Investor’s CAFE

Skousen Investor CAFÉ is a weekly electronic newsletter written by Dr. Mark Skousen. Mark offers commentary on the markets, the economy, politics and other topics of interest and what they mean to individual investors. Sign up for FREE here.

FreedomFest Conference

FreedomFest is an annual festival in Las Vegas where free minds meet to celebrate “great books, great ideas, and great thinkers” in an open-minded society. It is independent, non-partisan, and not affiliated with any organization or think tank.

Anthem Film Festival

Anthem is the only film festival in the country devoted to promoting libertarian ideals. Anthem shows films and documentaries that celebrate self-reliance, innovation, commerce, individual rights, and the power of persuasion over force. We are looking for the year's best films about personal and civil liberty.